When Stock is Vested

Generally, stock is vested when you
have a right to keep it — even if you can't sell it
right away.

If you acquire stock from your employer, the tax consequences depend on
whether the stock is vested. In the language of the IRS, the question is
whether you have a substantial risk of forfeiture. These words have a special
meaning. In general you have a substantial risk of forfeiture — and your stock
isn't vested — if termination of your employment would cause you to lose some or
all of the value of your stock.

General rule

Stock you receive as compensation is vested if either of the
following are true:

You have the right to keep the stock — or receive fair market
value for it — even if you quit or get fired.

You have the ability to transfer the stock to another person, free
of any restrictions.

Forfeiture of stock

The simplest example of a risk of forfeiture is where you
receive stock from your employer but have to give it up if your
employment terminates within a specified period of time. Stock
received under these conditions isn't vested. Your stock becomes
vested when your employment continues long enough so you don't
have to give the stock back upon termination.

Forced sale of stock

Your employer may insist that you sell your stock back to the
company if your employment terminates within a specified period.
This requirement may or may not create a substantial risk of
forfeiture.

Sale for the price you paid. If you paid for the stock when
you acquired it, you may have agreed to sell it back for the same
price you paid. This requirement is a substantial risk of forfeiture
because termination of your employment may cause you to lose the
benefit of any increase in the value of the stock.

Sale for fair market value. You may have agreed to sell the
stock back for its fair market value. This requirement is not a
substantial risk of forfeiture because you don't lose any current
value when your employment terminates. You lose the ability to
participate in future growth of the company after the forced sale, but
that loss doesn't count under this rule.

Termination for cause

You may have agreed that you forfeit the stock if you're
terminated for cause. The tax regulations say this is not a
substantial risk of forfeiture, apparently because this is a
relatively rare and unexpected event.

Decline in value

The risk that your stock will decline in value is not a
substantial risk of forfeiture. This may be a genuine risk of
loss, but it's not the kind of risk that's covered by this rule.

Section 16b restrictions

The Securities laws require certain executives of public
corporations to disgorge (give up) any profits they have on
sales of stock that occur under certain conditions. (These rules
generally apply only to board members and certain top
executives, so if you haven't heard about them they probably
don't apply to you.) For tax purposes your stock is considered
restricted (not vested) until such time as you can sell it at a
profit without being subject to a suit under section 16b of the
Securities Exchange Act of 1934. The interaction between the tax
rules and section 16b is complicated, and the IRS hasn't
explained how these rules work in connection with the current
version of the section 16b regulations. If you're subject to
section 16, you should strongly consider making the
Section 83b Election when you acquire stock — even in an
"exempt" transaction. The reason: the sale of this stock isn't
necessarily an exempt transaction even if the acquisition was.

Permanent restrictions

What if you have a restriction that never terminates? In the
terminology of the tax law, this is a non-lapse restriction.
Regardless of what you call it, you don't have a risk of
forfeiture when this type of condition exists. The vesting rules
deal only with restrictions that will lapse (or terminate) after
some period of time, or if a particular event occurs.

Non-competition agreements

Normally a risk of forfeiture is connected with continuing
employment. But it can also be attached to an agreement not to
compete or similar obligation. If you receive stock under an
agreement that says you'll forfeit it if you compete with the
company that granted the stock, you may have a substantial risk
of forfeiture.